Why We Shouldn’t Ask Economists About NAFTA

By Donella Meadows

–September 9, 1993–

More than biotechnology or weapons technology, more than any other change in our rapidly changing world, the globalization of the economy is affecting everyone on the planet, and not for the better. If we value democracy, the environment, or our jobs, we need to keep an eye not only on the North American Free Trade Agrement (NAFTA), which is about to go before our Congress, but on Europe’s Maastricht Agreement and the world’s General Agreement on Tariffs and Trade (GATT). These treaties are bulldozers bearing down on the rights, efforts, resources, and hopes of individuals, communities, businesses, and nations.

There are many reasons for making such a strong statement. The main one is that the central argument for free trade — the 200-year-old theory of COMPARATIVE ADVANTAGE — has a fatal flaw.

Assume, to take the kind of example you find in economic textbooks, that Mexico and the U.S. each make just two products, cars and corn. Assume that in the U.S. it costs $10,000 to make a car and $5 to grow a bushel of corn. And in Mexico, because of low wages and laughable environmental standards, it costs $8000 to make a car and $2 to grow a bushel of corn.

It wouldn’t take long for some entrepreneur to notice that he could buy a car for $10,000 in Texas, drive it over the border, and trade it for 4000 bushels of corn in Mexico. Then he could haul the corn north and sell it for $20,000 at the American price — clearing $10,000 (minus transportation costs) on the deal. Without trade barriers, cars would soon be roaring south and corn roaring north.

That trade would be powered by the fact that Mexico has an ABSOLUTE advantage (lower production cost) in both cars and corn, but it has a COMPARATIVE advantage in corn, while the U.S. has a comparative advantage in cars. Comparative advantage comes from the cost ratios WITHIN each country, not the ratios between countries.

The corn-car trade would make everyone better off, say economists. Suppose the U.S. has, say, $250 million and Mexico $100 million worth of inputs — labor, land, capital, energy, and other factors of production — to invest in the production of corn or cars each year. If the countries don’t trade, and if they divide their inputs equally between the two products, the U.S. can produce 12,500 cars and 25 million bushels of corn a year. Mexico can produce 6,250 cars and 25 million bushels of corn. But if the U.S. puts its whole $250 million into cars, it can make 25,000 of them — more than both countries were making before. If Mexico produces only corn, it can grow 50 million bushels — the same amount both countries produced before. More cars, no loss in corn. This is the kind of win-win outcome the economists predict, if we open our borders with Mexico.

There are many ways in which this little example does not apply to the real world. The one that pulls down the whole argument is the assumption that the $250 million and $100 million worth of inputs will stay in their original countries. Two hundred years ago that was a safe bet. The major input to production of almost anything was land, which wasn’t likely to flow across national borders. Movements of people were difficult back then, and movements of factories, finance, and management were nearly impossible.

Nowadays, land is a minor input in terms of cost even to agriculture. Labor crosses borders relatively easily, laws or no laws. But the biggest change is in the mobility of capital. If $250 million can produce more in one country than another, it flows over a computer network, literally with the speed of light, not to where there is comparative advantage, but to where there is absolute advantage. Behind it, with astonishing speed, flow factories, energy systems, delivery systems. In the example above, investment in both cars and corn would flood south. The only way the U.S. could keep production at home would be to bargain down its wages and environmental standards to the levels of Mexico — or to set up barriers against capital flight.

Ross Perot’s “giant sucking sound” is a real concern. The more NAFTA, GATT and other trade agreements allow capital to flow freely across borders, the more investors will seek out the lowest labor and environmental standards, wherever they are.

You’d think economists would notice this gaping hole in their theory, and some have. But when you’re part of a guild that has thought a certain way for 200 years, you automatically use old thinking for new problems. The computer models employed to analyze the consequences of NAFTA — the ones that tell us 200,000 or 800,000 or whatever jobs will be gained in the United States — are built around assumptions such as these: capital is immobile; labor costs are the same in both countries; Americans will buy American-made goods even if Mexican-made goods are cheaper; imports to the U.S. from Mexico will always be balanced by exports; any U.S. worker unemployed by NAFTA will find another job in new export industries.

Those are not assumptions upon which you’d want to bet your job or your environment. In the coming months, as politicians and their hired heads tell you how much better off you’re going to be after NAFTA, ask them how they know that. Keep asking. Poke into their models. You have a right to ask that those models be explained until you understand them. What you’ll find at their foundation is the old, dead theory of comparative advantage.

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About The Donella Meadows Project

The mission of the Donella Meadows Project is to preserve Donella (Dana) H. Meadows’s legacy as an inspiring leader, scholar, writer, and teacher; to manage the intellectual property rights related to Dana’s published work; to provide and maintain a comprehensive and easily accessible archive of her work online, including articles, columns, and letters; to develop new resources and programs that apply her ideas to current issues and make them available to an ever-larger network of students, practitioners, and leaders in social change. Read More

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